Operations

5 Common Mistakes in Negotiating a Fleet Lease Agreement

May 28, 2009
• by Staff

You’ve gone through the RFP process, selected a lessor, and now it’s time to negotiate the agreement. Sometimes, it might seem all lease agreements are the same and little is left to actually negotiate beyond the typical legal wrangling about which state’s laws will govern the contract, etc.

However, fleet managers are wise to read the entire document and familiarize themselves with the terms and conditions under which they will be doing business. For the business side of the contract, not the legal side, most impacts the fleet manager, and key provisions can be overlooked.

Discussing the BasicsFor the purpose of this article, a fleet lease agreement refers to the open-end TRAC (Terminal Rental Adjustment Clause) lease, the most common lease used by mid-size and large fleets. The open-end lease is unique to the fleet industry, and most contain some basic terms under which the lessor and lessee do business. This article examines the business side of the contract, and does not address legal issues.

The terms and conditions appearing in most such master lease agreements are:

■ Minimum term: Each vehicle leased under the agreement must remain in service for a minimum term before being replaced.■ Vehicle capitalization: Describes how vehicles leased under the agreement will be capitalized.■ TRAC: This clause governs vehicle termination and sale when taken out of service.■ Termination: Defined standard terms of advance notification when either party wishes to terminate the contract.■ Payment: Details payment terms, frequency of billing, and prompt payment discounts.

Open-end fleet agreements are master agreements. They contain overall terms and conditions applied individually to each lease vehicle. For example, the capitalization schedule is set by the manufacturer, with cost pegged as a function of factory invoice. Each vehicle delivered is capitalized, and lease payment calculations are based on the master agreement criteria.

The lessor then produces the “Schedule A,” which provides an accounting for the cap cost and outlines the lease payment schedule. When vehicles are taken out of service and sold, a “Schedule B” is produced, detailing calculations resulting from the TRAC application, unamortized balance, sale proceeds, and excess or shortfall of such proceeds when applied to the net book value.

1. Capitalization Schedule

Most domestically manufactured fleet vehicles usually are capitalized at a discount off factory invoice cost, and in some instances, import-badged vehicles as well. Exceptions occur, including some luxury models or makes and vehicles purchased from dealer stock for emergency orders.

The discount is part of the “holdback,” which represents 3 percent of the vehicle’s MSRP. For example, $600 is the holdback for a vehicle with a $20,000 MSRP. The vehicle’s net price to a dealer is factory invoice less the holdback.

Thus, if a contract capitalizes the vehicle at $450 under invoice and the factory invoice is $17,000, the cap cost is $16,550. Assuming the following model-year the factory invoice is $17,500, the contract cap cost is $17,050.

Fleet managers often miss the opportunity to negotiate a capitalization schedule of “net-plus” rather than “invoice-minus.” The benefit is that as vehicle prices increase, a net-plus schedule offers the fleet part of the increase.

In the example cited, a cap schedule of $100 over net-invoice would cap the vehicle at a lower cost — as the factory invoice increases, so does the holdback. The savings can add up quickly.

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2. Billing Inception

Most fleet lease contracts contain a “15th/15th” billing inception. Vehicles brought into service before the 15th of the month are billed for the entire month; those in service after the 15th are billed in the following month. The converse holds true for vehicles removed from service. Those removed prior to the 15th are not billed for that month, after the 15th, they are.

The issue that bears careful research and negotiation is the latter. The problem is defining exactly when a vehicle is out of service — when the company turns it in to the lessor and the new vehicle is delivered, when it is sold, or when proceeds are applied to billing? Fleet managers are wise to define the out-of-service date in the contract.

To be fair, the out-of-service date should be the date of sale. At that point, the lessor has the proceeds, and fleet should not be forced to wait until the proceeds are applied to the billing. A delay of only a day or two can make the difference in an additional monthly bill.

Finally, agreement should be reached on a reasonable time frame for a vehicle sale once the fleet has dropped it off. This stipulation can be part of a service level agreement, the next topic.

3. Service Level Agreement

Another mistake fleet managers often make is not incorporating a service level agreement (SLA) into the contract or as a separate agreement signed by both parties.

A perfect example of the need for an SLA is the billing cycle question. The agreement can state vehicles, once dropped off for sale, must be picked up by the lessor and sold within a mutually agreed-upon time period.

These are just a few examples of the types of performance levels the contract should contain. Service level agreements, rare just a decade ago, have become more common and should be an integral part of any contract negotiation.

4. Interim Rent

For truck fleets that require upfitting on bodies, racks, lifts, and other specialized equipment, the question of interim rent arises. Truck chassis are factory-ordered and the lessor coordinates the drop-ship of the vehicle to the body supplier, where the upfit is performed and the finished vehicle shipped for delivery to the driver.

Upfits can take anywhere from one to several days or more, depending on the upfit complexity and size. However, the chassis must be paid for when delivered. The fleet manager must address this time lag in which the lessor has paid for the vehicle before it is completed and delivered.

The simplest and fairest way to cover the lessor’s cost of funds is to agree on an interest charge on the chassis’ capitalized cost from delivery to upfit completion.

Keep in mind at this point, the completed vehicle may be subject to the “15th/15th” rule for billing inception; however, agreement on the interim interest cost issue is the overarching point of negotiation. Lessors must pay for the chassis when delivered, whether or not the lessee has access to it. Thus, it is perfectly reasonable lessors require this cost be covered. The points of negotiation are how much, when, and for how long.

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5. Depreciation Reserve

A critical part of the lease rate factor is depreciation reserve. The greatest value of a fleet open-end TRAC lease concept is the flexibility to take vehicles out of service when most cost efficient.

In theory, each vehicle is amortized (the original capitalized cost reduced in equal monthly increments) at a rate that, when the vehicle is sold, results in an unamortized balance reflecting actual fair-market value as accurately as possible.

The most common rate of depreciation reserve historically has been 50 months or 2 percent per month. However, for a geographically spread fleet, a “one size fits all” depreciation rate does not exist.

Different vehicles accumulate mileage at different rates, have different uses, and thus depreciate at different rates. Many master fleet lease agreements try to limit the rate at which vehicles can be amortized to six years.

Fleet managers know this practice is not always for the best. In some truck applications, six years doesn’t even cover the anticipated lifecycle. Some higher-level vehicles, for example those used in executive applications, retain their value at rates far higher than the typical fleet four-door, intermediate sedan or ½ ton pickup.

The point of negotiation is to determine the length of the depreciation reserve. Is seven or eight years too long? For trucks with long lifecycles, amortizing at the standard 50 months, or even seven years, does not achieve the goal of a fleet TRAC lease — the unamortized balance at term end is roughly equivalent to the market value when sold.

Making certain the fleet manager has the flexibility to establish depreciation reserve rates that approximate the ultimate market value is an important point of negotiation. While a fleet lessor seldom has an issue with shorter reserve rates (24 or 36 months, for extremely high-mileage vehicles or those that experience rough usage, such as sparsely-equipped work trucks), the ability to extend depreciation reserve rates beyond 60 months must be available.

Negotiating Firmly, But FairlyNegotiating a master lease agreement is one of the most critical processes any fleet manager undertakes. Avoiding mistakes and omissions can make certain the agreement fits the needs and goals of the company.

■ Fleet managers negotiate the business side of the agreement, not the legal side. Issues such as which state’s laws govern the agreement and other legal boilerplate terms keep the lawyers busy. ■ Read the entire agreement. Don’t skim over anything. Enter the process assuming everything is negotiable.■ Don’t simply negotiate price and fees; the management process can be every bit as important. ■ Hold lessors accountable for claims made in proposals. If they touted cost savings, negotiate those savings into the agreement. ■ Be firm, but fair. Suppliers, just like your own company, are entitled to make a profit on the products and services they provide to customers. Avoid discussions about what lessor profit margins are. Again, as with your company, their internal costs and margins are none of your business. ■ Don’t leave money on the table. Know what’s “out there.” Talk to peers. Survey the marketplace. Be specific — negotiate until a supplier says “no,” but don’t punish them for doing so.

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